Staples 2004 Annual Report Download - page 85

STAPLES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Business unit income increased $3.6 million in fiscal 2004 and $60.6 million in fiscal 2003. Excluding the non-
comparable results of our European mail order acquisition, business unit income increased $29.8 million in 2003. The
slight increase in business unit income in 2004 is the result of improved performance during the first half of the year in
our delivery businesses relating to the positive integration efforts in the businesses acquired in 2002, improvements in our
existing delivery businesses, and improvements in our retail businesses reflecting the implementation of our Back to
Brighton strategies. These results were primarily offset by the costs associated with the integration of the Office World
stores and the related impact of five planned Staples store closures in the United Kingdom, the integration of our two
delivery businesses in the United Kingdom, a slight decrease in sales in our delivery businesses in France in the second
half of the year compared to the prior year combined with increased investments in marketing which did not yield the
sales benefits that were anticipated. The improvement in 2003 was achieved despite a challenging economic environment
and primarily reflected the turnaround in our German retail business and the positive impact of our integration process
on our existing delivery business. Our business unit income also benefited from the positive impact of foreign exchange
rates in both 2004 and 2003. We believe that we have a significant opportunity to grow our International business by
expanding our multi-channel offering in Europe and expanding into new geographies.
Critical Accounting Policies
Our financial statements are based on the application of significant accounting policies, many of which require
management to make significant estimates and assumptions (see Note A to the Consolidated Financial Statements). We
believe that the following are some of the more critical judgment areas in the application of our accounting policies that
currently affect our financial condition and results of operations.
Inventory: We record inventory at the lower of weighted-average cost or market value. We reserve for obsoles-
cence, overstock and inactive inventory based on the difference between the weighted-average cost of the inventory and
the estimated market value based on assumptions of future demand and market conditions. If actual market conditions
are less favorable than those projected by management, additional reserves may be required.
Purchase and advertising rebates: We earn rebates from our vendors, which are based on various quantitative
contract terms that can be complex and subject to interpretation. Amounts expected to be received from vendors relating
to the purchase of merchandise inventories and reimbursement of incremental costs, such as advertising, are recognized
as a reduction of inventory cost and realized as part of cost of goods sold as the merchandise is sold. Several controls are
in place, including direct confirmation with vendors, that we believe allow us to ensure that these amounts are recorded
in accordance with the terms of the contracts.
Impairment of Long-Lived Assets: We review our long-lived assets for impairment when indicators of impairment
are present and the undiscounted cash flow estimated to be generated by those assets is less than the assets’ carrying
amount. Our policy is to evaluate long-lived assets for impairment at a store level for retail operations and an operating
unit level for our other operations. Our retail stores typically take three years to achieve their full profit potential. If
actual market conditions are less favorable than management’s projections, future write-offs may be necessary.
Impairment of Goodwill and Indefinite Lived Intangible Assets: Statement of Financial Accounting Standards
No. 142 ‘‘Goodwill and Other Intangible Assets’’ (‘‘SFAS No. 142’’) requires that we annually review goodwill and other
intangible assets that have indefinite lives for impairment and when events or changes in circumstances indicate the
carrying value of these assets might exceed their current fair values. We determine fair value using discounted cash flow
analysis, which requires us to make certain assumptions and estimates regarding industry economic factors and future
profitability of acquired businesses. It is our policy to allocate goodwill and conduct impairment testing at the individual
business unit level based on our most current business plans, which reflect changes we anticipate in the economy and the
industry. If actual results are not consistent with our assumptions and judgments, we could be exposed to a material
impairment charge.
Deferred Taxes: We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely
than not to be realized. We have considered estimated future taxable income and ongoing tax planning strategies in
assessing the amount needed for the valuation allowance. If actual results differ unfavorably from those estimates used,
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